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Tuesday, October 07, 2008

Solving the funding problems of the Employee Pension Scheme (EPS)

Vikas Dhoot has an important article in Financial Express today on changes being made to the Employee Pension Scheme (EPS). This is a fairly underfunded defined-benefit pension scheme created in 1995. The scheme was broke to start with. From 1995 onwards, interest rates have dropped, and mortality has gone down. These factors have worsened the funding status of the scheme. For more details on EPS, see this paper.

EPS is broke, and the only way to make ends meet is to increase contributions and/or decrease benefits. It is to the credit of the UPA that they are doing these politically unpopular things. However, this illustrates the three pathologies of defined benefit schemes. First, they are prone to get into funding trouble owing to elongation of mortality. Second, bringing the schemes back into balance is politically unpopular, and in the meantime, this induces costs on the taxpayer. Third, bringing them back into sound territory often involves reducing benefits. To this extent, they are actually not as `defined' a benefit as is often claimed.

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